If you logged in yesterday and saw your bank account balance was $5000, but today you notice your account dropped to $4500 unexpectedly, I bet you’d be concerned and upset-- and that is normal. You would call your bank in a panic wondering where that money went. But, retirement accounts aren’t the same as your bank account.
A retirement account, generally speaking, is a way for you to save. Think of retirement accounts as shopping baskets at a grocery store. Some carts are small. Some are larger. Some are even flat-bed carts. Each cart has a different purpose and function. Some examples of retirement “carts” are 401K, IRA, 403B and pension plans. Each of these different types of retirement “carts” have different purposes and functions. While shopping carts at a grocery store will carry your milk and shampoo to the check-out lane, your retirement account will carry your investments to the “check-out lane” (retirement).
Now, I have quite a few clients who will look at their retirement statement, notice that their account balance is down, and have a mini (or full-on) panic attack. It’s a natural response when you feel like your money… your future… is in danger. But, take a step back, because it is important to remember that your investments will go up and down during the course of a day, week, month and year. That is normal and even healthy!
To understand why your investments will fluctuate, you must first understand that the market fluctuates. This is where your bank account differs from your retirement account. In your retirement account, 1 share could have large fluctuations in value. Some days, the value may drop 25%. On others, the value may go up 50%. Fluctuation is normal.
Consider this example: ABC stock sells for $20 per share. A young investor that has long-term investment goals decides to put 100 shares in his “cart.” That will bring his balance to $2000. He checks his account and notices that the balance drops from $2000 to $1500. Yes, the value dropped 25%, but bear in mind he still owns 100 shares of that stock. The fluctuation swings the other way in the next statement, revealing that his initial investment of $2000 is now valued at $3000-- a value increase of 50%!!
As the value of your account drops and raises, it is important to continue to buy shares each month. By doing this, you are participating in dollar cost averaging, which means you use a set fixed dollar amount on a regular schedule to purchase investments regardless of the price of that investment; thus reducing your overall “cost” of the fund. Now, there is no guarantee that you will not lose money on your investments, but, on average, your cost per share could be lower than compared to a lump sum.
I hope this explanation gives you a different perspective on your retirement statements. If you have to look at your account on a continuous basis, try focusing on the amount of shares you have and not the value of the account.
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Investing involves risk including the potential of principal. No investment strategy can guarantee a profit or protect against loss. Dollar cost averaging involves continuous investment in securities regardless of fluctuating price levels. Before starting such a program, you should consider your ability to make purchases through periods of fluctuation price levels.